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The factors that have prompted investors to pull in their horns over the past two months are likely to melt away in the months ahead, and finally wake the bulls. But there are several potential surprises - positive and negative - in the next 12 months that could change the sharemarket outlook.

By Alan Kohler, Eureka Report

Three years after the financial crisis and recession sparked by the collapse of investment bank Lehman Brothers, it is clear that this is not a normal recovery.

The global economy is recovering, but more slowly than usual, and the sharemarket has been flat for two years. The secular bear market that began in March 2000 (in the US) grinds on, with cyclical ups and downs; right now it's down, which presents an opportunity. Share prices look cheap and the factors that have prompted investors to pull in their horns over the past two months are likely to melt away in the months ahead.

As always, though, there are many factors that could change the outlook, both for the better and for the worse. Here are 10 of them - five possible positive surprises and five negative surprises.

Pleasant surprises

1. The Chinese boom restarts

In June, Chinese Premier Wen Jiaboa declared victory in the fight against inflation, which is a signal that the clamps on lending designed to curb price rises will be eased. China's economic growth has come back from 12 per cent to around 9 per cent as a result of the authorities' battle against inflation. If that's over, there is no reason to think growth will not snap back to what it was as the greatest and fastest industrialisation in history picks up speed. China is now in the sweet spot for commodity demand - typically above US$4000 per capita GDP (it is currently US$7000) - and any increase in growth is likely to produce a significant increase in demand for Australia's bulk exports.

2. The Australian dollar falls

The market expects the Australian dollar to remain well above parity with the US dollar because of the fiscal problems faced by the United States, as well as the likelihood of strong commodity prices and Australian interest rates. That is the most likely outcome, but there is a credible body of opinion that says the dollar is overvalued and likely to fall, at least in the short term. If it does, the profitability of Australian exporters will improve and many domestic industries will do better as well. In a sense, this is Australia's insurance policy, as it was in the Asian crisis of 1997: if other things do not go well, the dollar will make it better.

3. Greece does not default

It will not default this year and maybe never, at least in the formal sense that would cause a financial contagion. But markets have put in place an insurance policy against just this happening by taking some risk off the table, as it were. If the half-expected Greek default does not happen - and I don't think it will - then markets will rally as the insurance policy is removed.

4. The Australian investment boom kicks in

Hardly a surprise, but very positive. The capital expenditure intentions suggest that Australia's resources boom will get going in earnest in the next financial year. It has been coming for a while now, and the dollar went above parity in anticipation, but this is the year it happens. The beneficiaries will be the construction and service companies, as well as labour hire firms such as Skilled Group. Unemployment, already under 5 per cent, will head towards 4 per cent. The bad news is that this will mean interest rates are likely to rise during the course of the next financial year, possibly three times.

5. Telstra hits $4

OK, this is a big call. But I think the deal with NBN Co is very good for Australia's largest telco. Telstra will receive something like $1.5 billion a year for 10 years for renting its underground ducts for the NBN as well as "decommissioning payments" - compensation for shutting down its copper network and transferring customers to the NBN. Once that compensation runs out, Telstra will keep getting about $750 million a year for another 20 years for duct rental. The cash will underwrite its dividend, help pay for the marketing needed to hold market share in an NBN world, and fund growth.

Nasty surprises

1. Interest rates go up twice more

This is the downside of the resources boom. Unemployment below 5 per cent and falling means the Reserve Bank has its finger on the interest rate trigger, with a 'bias' towards raising. Retailing, already struggling because of the rate rises last year as well as the effect of online shopping, will be hit again, along with other consumer-based industries.

2. The US does not agree on budget cuts

Default by the United States is hard to imagine and outright debt rescheduling along the lines of Argentina is very unlikely. But as the chief economist of Citi, Willem Buiter, put it in an interview with me recently, the US has social democratic spending and Tea Party taxation. There is a fundamental flaw in US governance caused by the fact that society is so deeply polarised, with the result that both left and right tend to get their way - very high, Scandinavian social welfare spending but without the taxation to match. It is hard at the moment to see how this will be resolved, but it must be. Unless the Administration and Congress get spending under control or raise taxes, the US will eventually default on its debt. It will not happen in 2011-12, but it will start to become obvious during the next 12 months whether they have what it takes to deal with it.

3. The 'Arab Spring' revolutions spread to Saudi Arabia

The 'Arab Spring' succession of revolutions in the Middle East, beginning with Tunisia in December last year, has hit a brick wall called Bashar al-Assad in Syria. Even as Moamar Gaddafi in Libya is charged with war crimes and his HQ in Tripoli is bombarded by Nato, Assad continues to murder his citizens, apparently with impunity. But when Arab people-power was in full swing with the revolution in Egypt in February, it seemed only a matter of time before it spread to Saudi Arabia. As a result, the oil price spiked to US$115 a barrel, helping to cause the global recovery to falter. Brutal crackdowns in Bahrain and Syria, and a drawn-out civil war in Libya have bogged down the 'Arab Spring', but there is no reason to think it is dead and buried. Arabs clearly want democracy and see no reason why they should not have it. At some point they will return to the streets, perhaps in Saudi Arabia as well.

4. Spain defaults

All the focus lately has been on Greece, but Spain is in deep trouble as well. Unemployment is 21.3 per cent and rising; for youth it is 45 per cent. Debt to GDP is at a relatively moderate 68 per cent but the budget deficit is currently 10 per cent of GDP. The current-account deficit has remained in a reasonable 4-6 per cent of GDP range during the crisis, but looks set to increase. Spain must balance fiscal austerity with the need to stimulate growth and, more critically, employment. Any slowdown from the already meagre 1.3 per cent growth could easily throw Spain back into crisis. There has been a 35 per cent sell-off in Spanish bank shares so far this year, which does not bode well.

5. Retailing does not pull out of its downturn

Part of the problems in Australia's retailing sector are due to cyclical issues associated with the high savings rate and low spending, caused by high interest rates and petrol prices, and concerns about debt. But a large and unknown part of the problems are structural - the shift to online shopping. This has been accelerated by the high Australian dollar, making overseas purchases cheaper, but there is a profound change taking place in society with the shift to digital. Fewer shops will be needed in future and those that survive will have to work harder to attract customers.

About the author

Alan Kohler is the publisher of Eureka Report, a leading investment newsletter.

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